ECONOMICS 3200B Lecture 2 Ch. 1, 2, 3 September 17, 2013 - PowerPoint PPT Presentation

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ECONOMICS 3200B Lecture 2 Ch. 1, 2, 3 September 17, 2013

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Title: ECONOMICS 3150B Author: lazar Last modified by: Fred Lazar Created Date: 12/27/2011 6:37:09 PM Document presentation format: On-screen Show (4:3) – PowerPoint PPT presentation

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Title: ECONOMICS 3200B Lecture 2 Ch. 1, 2, 3 September 17, 2013


1
ECONOMICS 3200BLecture 2Ch. 1, 2, 3September
17, 2013
2
Introduction
  • Decision making
  • Objectives
  • Information
  • Constraints
  • Trade-offs
  • Time horizons
  • Role of self interest, aka greed
  • Scarcity
  • Distributional issues equity, fairness
  • The 1ers

3
Introduction
  • Decision making
  • Forward looking Information requirements and
    uncertainty
  • Time horizon short run vs. long run
  • Adam Smith individuals pursuing their own self
    interest will collectively produce the greatest
    good ? Greed is good, Economics 101
  • Importance of incentives individuals motivated
    by personal well-being

4
Introduction
  • Decision making
  • Constrained optimization
  • Constraints
  • Character, history, skills, risk tolerance
  • Competitors strategies
  • Time
  • Resource constraints short-run/long run (i.e.
    availability of resources, quality)
  • Laws, regulations
  • Others directors, investors, competitors,
    creditors (loan covenants), contracts

5
Introduction
  • Economic paradigms
  • Perfect competition many firms, homogeneous
    products
  • Monopoly one firm (seller)
  • Contestable
  • Monopsony one firm (buyer)
  • Oligopoly small numbers
  • Monopolistic competition many, heterogeneous
    products

6
Introduction
  • Problem Competition
  • Passive/active?
  • Rivalry the goal of competition is to kill
    your competitors
  • Compare to concept of competition in perfect
    competition model
  • Michael Porter Determinants of rivalry
  • Concentration and balance (Herfindahl-Hirschman
    index, concentration ratios) facilitate
    collusive behavior, deter entry, dominant firm
  • Threat of entry, exit barriers
  • Product differentiation brand identity,
    switching costs, reputation
  • Informational complexity
  • Intermittent overcapacity airlines, steel
  • Bargaining power of buyers
  • Industry growth

7
Introduction
  • Are suppliers/competitors (including potential
    entrants) equally well-informed?
  • Perfect information?
  • Role of Internet, role of social networks, B2B,
    B2C
  • Implications for stability of entry/exit process
  • Implications for innovation

8
Introduction
  • Michael Porter Competitive strategy
  • Establish profitable and sustainable position
    factoring in bargaining power of suppliers and
    buyers, threat of entry, threat of substitutes,
    intensity of rivalry
  • Strategies for achieving competitive advantage
  • Cost leadership
  • Differentiation
  • Niche
  • Role of management and luck
  • Gamblers ruin and industry concentration

9
Introduction
  • Sustainability of competitive advantage
  • Barriers to imitation not insurmountable, thus
    firm must create moving target by investing to
    continually improve position
  • Well executed offensive strategy best defense
    against attack by challenger
  • Role remains for defensive strategy increase
    structural barriers to entry, increase
    probability of retaliation retaliate when entry
    attempted
  • Deeper pockets
  • Risk-taking vs. risk aversion role of
    regulations, fear of liabilities

10
Introduction
  • Problem Market definition
  • Identification of buyers, sellers potential
    entrants, potential sources of supply
  • Geographic scope
  • Local, regional, national, international
  • Trade barriers, information
  • What constitutes a substitute product?
  • Cross-price elasticities measurement, critical
    values
  • MRgt0 elastic range of demand curve, thus high
    degree of substitutability with products that are
    not included in market
  • Substitutability over time alternative energy
    sources

11
Introduction
  • Entry barriers ease, speed of entry
  • Entry by outsiders (who are they?) entry by
    insiders
  • Height, perception of entry barriers
    reputation, economies of scale/scope, learning
    curves, access to distribution networks,
    switching costs, firm specific capital (patents,
    trade secrets, management skills, location)
  • Strategic behavior of incumbents entry
    accommodation or deterrence
  • Time period for defining markets time required
    for adjustments in buyer/seller behavior in
    response to certain size price change

12
Introduction
  • Problem Information
  • What do buyers know about availabilities, prices,
    quality?
  • Search costs
  • Uncertainties re. quality signals by firms for
    quality (advertising, warranties, investments in
    creating brand names)
  • Limited search enhances market power of each firm
  • Impact of Internet search sites
  • What do suppliers know about technologies
    (product, production), consumer tastes, price
    elasticity, number and location of buyers, number
    and competencies of rivals, cost structures of
    rivals, strategies of rivals
  • Role of B2B impact on relative bargaining
    advantages
  • What do potential entrants know?
  • Impact of Internet

13
Introduction
  • Competition
  • Schumpeter
  • This process of creative destruction is the
    essential fact about capitalism. Every piece of
    business strategy must be seen in its role in the
    perennial gale of creative destruction.
  • Bob Crandall
  • Kill your competitor
  • Porter
  • Competitive advantage

14
Introduction
  • Among 50 wealthiest Carlos Slim (1), Bill Gates
    (2), Amancio Oretga (3), Li Ka-shing (8),
    Bernard Arnault (10), Stefan Persson (12),
    Michael Bloomberg (13), Jeff Bezos(19), Larry
    Page Sergey Brin (20 and 21), Mukesh Ambani
    (22), Carl Icahn (26), Alberto Gonzalez (32),
    Mikhail Fridman (41), Lakshmi Mittal (41),
    Aliko Dangote (42), Mark Zuckerberg (66)

15
Introduction
  • Theory If, then
  • If perfect competition, then PMC
  • If monopoly, then, PgtAC
  • If no entry barriers and zero exit costs, then
    markets contestable and PAC
  • If economies of scale to Q0 and diseconomies of
    scale beyond Q0 , then AC curve is U-shaped
  • If oligopoly, then ???
  • If heterogeneous product, then monopolistic
    competition
  • If economic profits, then entry occurs

16
Introduction
  • Common shortcomings
  • Time short run vs. long run
  • Market/industry boundaries
  • Competitive behavior competitive strategies,
    competitive advantage
  • First entrant
  • Tipping point
  • Networks
  • Evolution of technology
  • Disruptive technologies

17
Introduction
  • Problem Many paths to the if, thus many paths
    for then
  • Example Monopoly
  • How was monopoly created?
  • Government, natural monopoly, successful
    strategies, superior management, luck
  • Entry barriers created as part of process?
  • Depends on how monopoly created
  • Strategies to sustain monopoly?
  • Rent seeking public vs. private sector
  • Sustainability

18
Introduction
  • Decision making
  • Adam Smith individuals pursuing their own self
    interest will collectively produce the greatest
    good ? Greed is good (Gordon Gekko, Wall Street
    I), Economics 101
  • Margin Call You succeed by being fist, being
    smartest or cheating
  • Importance of incentives individuals motivated
    by personal well-being
  • Politicians Quebec municipal governments
    Africa
  • Sub-prime loan markets, Madoff and Ponzi,
    derivatives CDS, traders bond vigilantes
  • What about altruism George Clooney, Angelina
    Jolie, Mat Damon?
  • Giving pledge initiative Gates and Buffett

19
Introduction
  • Time horizon
  • Longer the time horizon fewer constraints, more
    uncertainty
  • Temporal interdependence among decisions made at
    different points in time
  • Increasing complexity
  • Shorter time horizon
  • Tradeoffs
  • Rash behavior
  • Susceptibility to herd mentality safety in
    numbers

20
Introduction
  • Markets and players
  • What is a market? What is capitalism?
  • Reliance on markets role of uncertainty, number
    of competitors
  • Rules and regulations role of governments
  • Ex ante vs. ex post rule making political risk
  • Ability to influence rule makers
  • Market boundaries Whos in, whos out?
  • Whos waiting to get in?
  • Are the boundaries shifting?
  • Geographic/product?

21
Introduction
  • Teams
  • Creation of clubs/teams tribalism
  • Reinforce early success
  • Limit competition among members
  • Economies of scale
  • Solution to imperfect information, absence of
    trust
  • Enhance benefits for all members
  • Exclusionary
  • Language, race, religion, culture, nationality,
    socio-economic

22
Introduction
  • Firms
  • Organization that transforms inputs into outputs
  • Collection of people working as team
  • Existence of firms
  • Limited liability raising capital
  • What does a firm maximize?
  • Who makes the key decisions and why?
  • Separation of ownership and control
  • How is accountability managed within the firm?
  • How are they/how should they be organized?

23
Introduction
  • From here to there
  • Defining here
  • Choosing among all possible theres
  • Choosing the path to get there
  • Options created/foregone along each path
  • How long to get there along each path
  • What if there chosen proves to be the wrong
    one?
  • How do you find out?
  • Role of milestones and contingency planning
  • Leadership

24
Introduction
  • Risks
  • Margin for error PV/I
  • Confidence in data and analysis
  • Size of bet

25
Firms
  • What is a firm?
  • Legal structure corporations, partnerships,
    sole proprietorships
  • Ownership of a firm
  • Private, public, government, not-for-profit
  • Potash/Air Canada/Petro-Canada/CNR all started as
    Crown Corporations privatized
  • Is government ownership needed? Consider Hydro
    One, OPG, TTC, LCBO, CMHC, GTAA, AECL, CDIC,
    Canada Post, EDC, Via Rail
  • Objectives of a firm
  • Advantages of a firm
  • Organization and governance of firms

26
Existence of Firms
  • Technological
  • Transactions costs
  • Contractual

27
Existence of Firms
  • Technological
  • Team production
  • Economies of scale specialization through
    scale, learning by doing comparative advantage
    in use of resources larger number of production
    technologies available indivisibilities
  • Q(X10) Q(X20) lt Q(X10, X20)
  • Lower cost to meter/monitor team members
    internally within firm than externally via the
    market
  • Economies of massed reserves through ownership of
    assets
  • Insurance against machine breakdowns
  • Diversification across markets to reduce
    peak-load capacities
  • Indivisibilities/synergies in overhead functions
    sales, marketing, finance, engineering, legal,
    research, distribution
  • Economies of scope

28
Existence of Firms
  • Technological
  • Need to supervise/monitor/meter
  • Supervisor measures efforts, determines rewards
  • Bounded rationality limits scope of control
  • Rules for compensation subjectivity, favoritism
  • Who monitors the monitor?
  • Compensation to motivate employees
  • Seniority systems
  • Vested pensions less important because of
    systemic deficits with defined benefit plans
  • Performance-based bonuses

29
Existence of Firms
  • Technological
  • Limits because of diseconomies of scale
  • Shirking free riding benefits of leisure
    accrue to individual, costs of leisure (reduced
    effort) shared by all members of team
  • Monitoring and metering costs to minimize
    shirking
  • Difficulty in measuring individual
    effort/contribution
  • Bounded rationality, noise in transmission of
    information
  • Hierarchical organization structure
    guard/unproductive labor
  • Boredom and specialization
  • Motivation risk aversion

30
Existence of Firms
  • Value Chain and Internalization
  • Primary Activities
  • Raw materials ? Inbound Logistics ? Operations
    (Manufacturing) ? Outbound Logistics ?
    Marketing ? After-Sale Service
  • Operations can be sub-divided into
  • Fabrication of Materials ? Production of
    Parts ? Sub-assembly ? Final Assembly
  • For service activities, the value chain would
    look different

31
Existence of Firms
  • Value Chain and Internalization
  • Support Services, which overlay the Primary
    Activities
  • Firm Infrastructure finance, planning, legal
  • Human Resource Management
  • Technology Development
  • Procurement
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